Monday, October 2, 2017

Everyone's missing the second scariest thing about the Equifax story.

[Make sure to check out the comment thread. You also might want to take a look at the magical heuristics posts since we are definitely getting into magic of will here.]

As we mentioned before, the data gathering of Google and Facebook is almost entirely a bad thing from the user's perspective, something we tolerate because it comes with lots of features we do like and (often more importantly) it is generally done in such a way that we don't notice what's going on.

The data-gathering of the credit bureaus is just the opposite. It provides a service that is useful and even necessary to alleviate the asymmetry of information when seeking a line of credit. Since almost all of us fall into this group at some point in our lives, simply having the bureaus go away without creating something new to take their place is simply not an option.

The solution we collectively decided upon (or stumbled into) was something close to the public utilities model. Private companies that would be allowed to operate as government sanctioned semi monopolies granted special accommodations. We could go back-and-forth as to whether or not this was a better solution than setting up a government agency to warehouse our financial data, but once the utility model has been settled upon, we should all be able to agree that certain conditions hold.

The companies are exempted from antitrust rules and are allowed to do things that other companies aren't. In exchange, the companies must be heavily regulated and are locked into an extremely conservative business model. Since they provide an essential service, they cannot be allowed to take big or even moderate risks. Since they are given special government accommodations, they cannot be allowed to take unfair advantage of these. Thus, the companies should provide a remarkably safe and stable investment, but with limited returns. Any attempt to deviate from that can only be trouble.

Which brings us to this from the CEO of Equifax.
RICHARD SMITH: Our goal financially in the next five years or so is to go from about $4 billion of revenue to $8 billion, from a valuation of $20 billion to $40 billion. And to do that, we're focused on a couple of things important to us.

Of course, it is possible that the CEO was simply bullshitting the investors. That would be bad enough, but the other possibility is far worse. For a large, mature company like Equifax to double its revenue and valuation in a five-year period almost certainly requires risky behavior or making all possible use of any competitive advantage or probably both. The moment this statement went public it became obvious that the management of Equifax was either willfully misleading its shareholders and/or planning to abuse its position.

How did we get to the point where something this egregious goes unnoticed? For starters, there's the growth fetish – – the tendency to greatly overvalue growth over stable returns. Then there's the widespread modern belief that profit is proportional to social good. And, of course, there's hostility toward regulation. All bad individually, but potentially catastrophic when combined.

3 comments:

  1. I have been waiting for this piece for a bit and I am so, so happy to see it come out.

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  2. Mark:

    I don't know anything about credit bureaus so maybe this is a naive question. But, is it really true that to double within 5 years (or, realistically, to aim to double within 5 years), that this attempt "requires risky behavior or making all possible use of any competitive advantage or probably both."

    What about more other strategies, such as merging or acquiring another company in the same or a related industry, or expanding to other countries, or expanding to related product lines (perhaps, I dunno, evaluating the credit of online advertisers or something like that)?

    Again, I dunno, and I agree that the appropriate response to this CEO's claim is to ask him how he plans to do it---there's something screwed up about a world in which such a plan would be considered just business-talk-as-usual---but it's not so clear to me that he's necessarily "willfully misleading its shareholders and/or planning to abuse its position."

    So, I think I agree with you on the general point---and I'm in agreement on the ideological blinders that allow a company like this to be considered "private industry" and thus good (imagine if a government regulator announced a plan to double within the next 5 years!)---but I don't know enough context to evaluate your specific claims.

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    Replies
    1. Andrew,

      I need to address this in more detail but here are a few quick points dictated to my phone:

      The larger the company, the more difficult high growth rate becomes. The most famous exception to this (GE) was largely the result of risky behavior and accounting fraud.

      Because of the denominator, it is extraordinarily difficult for a few new products or services (such as evaluating online advertisers) to move the needle. This is a case where $100 million cash cow is literally too small to make a difference.

      Explosive growth for large corporations is especially difficult when you have mature companies or stable industries or saturated markets. (Or in this case, all three.)

      Acquisitions are never risk free. That said, some are safer than others, particularly buying up smaller competitors. The riskiest are outside of the industry (like a bank buying a cell phone company). Equifax acquiring any large company in the financial services industry would be an antitrust/conflict of interest/regulatory nightmare. Expanding into an overseas market would be extraordinarily problematic (most countries wouldn't even allow a homegrown Equifax to exist).

      We've come to accept, as a society, the notion that growth is something that is simply willed into existence. Rather than being the result of market conditions, technological developments, business logic, and trade-offs between growth/risk/opportunity cost, doubling the size of a company is something a visionary CEO simply decides to do.

      That belief does a lot of damage.

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